Tuesday, November 25, 2008

The Fannie Freddie Program Emerges

Fannie Mae and Freddie Mac were nationalized in August, and while that was horrific enough standing alone, I said at the time that the real horror would come in the government's new uses for the two mortgage giants.

News crossed this morning of a new program from the Federal Reserve to buy $500 Billion in mortgage backed securities from Fannie and Freddie and another $100 Billion of their debt. This is just the first buyback of many to come, but what does that mean to the real estate market?

We created a bubble in real estate because lenders were essentially allowed to make a home loan to anyone. This allowed more entrants into the market and more importantly a lot more speculators. Lenders could lend this way because they immediately sold the loans into the secondary market, and the secondary market then packaged those loans and sold them to the world.

The problem is that a very large portion of those loans are now going bad and investors around the world are taking tremendous losses. In a sane world, that would mean that they would not buy any more mortgage securities at the current bubble prices that Americans cannot afford to pay. That would mean that lenders would have to keep the loans on their books, and they would have to make only loans they felt would be safe and would not default.

This means homeowners would again have to put down 20%, have a job, ect. In order for homeowners to be able to do that home prices would have to collapse back down to an affordable level. That is the way a free market works, but the government will not let the natural market forces work.

What will happen now is that lenders will continue to make loans that are bad as long as they have the ability to immediately sell those loans to Fannie Mae and Freddie Mac. They are currently the only ones left to buy the toxic debt at bubble prices. The problem is that Fannie Mae and Freddie Mac now have to figure out a way to unload that toxic debt off of their balance sheet. The new Fed program provides the answer. They now buy the toxic debt and print new dollars to exchange with Fannie and Freddie.

I was watching CNBC this morning and they were laughing and smiling and one of anchors asked the other, "What comes after $999 Trillion, so we know what to call it when the bail out gets there?" The other one laughed and said I think it is a quadrillion.

The laughing will come to an end probably somewhere around 2010 when they realize what a trillion printed dollars does to a currency. Some people will be laughing, it will be the ones that understand today what effect it will have on our future.

Sunday, November 23, 2008

The Weekend Huddle

About a month ago we began what has now become the weekend huddle. It usually starts on a Tuesday or Wednesday during the week when a CEO makes a statement to the media that:

1. Their balance sheet is strong
2. They are confident moving ahead in the future

When you hear these two statements from a CEO of a major investment bank you can immediately know that they are in serious, serious trouble. Citigroup has been all over the news this week with these announcements and I told a few people that I would be ready for some bail out news as early as this weekend.

I even guessed the time the news would be released. 1:00 PM on Sunday. How did I know?

It happens the same way every time. I was even joking that maybe they pick the time because they are hoping people will be distracted with football and will be less likely to notice.

A few weeks ago I said that both Citigroup and Wells Fargo were in a war to acquire Wachovia because taking their bad debt on their books would make them too big to fail. They had this mind set because the government had let Lehman fail because they thought their impact would be minimal to the markets. They were wrong.

Wells Fargo ended up taking on the bad Wachovia debt and Bank of America then acquired all the bad Merrill Lynch debt. This now made them too "big to fail", or nationalized. Fortunately for Citigroup, Lehman's failure and market consequences has now made it clear to the government that they will not let ANYONE fail under any circumstances. All the banks have now been nationalized, and all would be insolvent without the new government guarantee.

They will now get an unlimited amount of dollars to keep their bad operations running. The same is true for the auto manufacturers, but not for the reason that many are talking about. The auto manufacturers failure would trigger massive losses in the credit default swaps market on their corporate debt, which would in turn trigger additional massive losses onto the banks balance sheets, which would trigger additional bail outs.

As the losses pour in hour by hour, we move closer to the point when the United States debt will be downgraded. Right now our treasuries are trading at AAA credit, just like subprime debt was trading at AAA in the fall of 2007. The similarities are eerie, and the outcome will be the same. The United States is currently on life support from foreign countries just as the investment banks are on life support from the United State government.

When the rest of the world figures out that the "AAA" treasuries they are holding are actually junk bonds, the bubble will explode and its impact will be deafening.